Outsourcing: A Shore Thing?

Outsourcing operations abroad may have established itself as a successful strategy for US firms looking to slash costs and seek out expertise but, according to some, the cracks in offshoring are starting to show. Up to now, the sector has been almost bulletproof. Manufacturing, business processes and IT services are just some of the operations that, in recent years, US firms have increasingly moved to outsourcing centers such as China, the Philippines and, in particular, India, where cheap, skilled labour is abundant.
The last few years have seen the offshoring sector soar, with annual growth rate in excess of 20 percent according to Meta Group. This year, the offshore outsourcing sector will become a US$7 billion market.

But all is not necessarily well in the industry. The annual global IT outsourcing study by management consultancy DiamondCluster is one of the most comprehensive outsourcing studies of its kind, surveying 210 buyers and 242 providers of such services. The latest study tosses up some statistics that may cause the industry to pause for thought. In particular, a marked drop in the number of buyers that plan to increase their use of offshoring over the next 12 months (from 86 percent to 70 percent) may set alarm bells ringing.
Ostensibly, it is fair to say that the reduction in offshore outsourcing growth rate could be a result of buyers having already outsourced many of their more commoditized IT functions that have become traditional areas for offshoring. But there is intriguing evidence to suggest that other factors are at play, not least that offshore outsourcing satisfaction rates have fallen significantly over the past year, from 79 percent to 62 percent.

Tom Weakland, Leader of the DiamondCluster global sourcing advisory practice, believes there are three major reasons why overall satisfaction with offshore has plummeted. Offshore outsourcing has grown so fast in countries such as India that the number of people that they have to do the services doesn't meet the demand in a lot of cases. There is a lot of competition for the best resources and they move from job to job for fairly small pay that translates into high turnover rates. When clients see that they have a different Account Manager every other week or see their quality going down they are not happy about it.

“The second reason is that because of the boom, there are more companies providing outsourcing services, all offering the exact same services so that it is hard to differentiate between them on anything other than price. When you are differentiating solely on price you are not necessarily getting the highest quality firm. So there are some lower quality firms out there that will probably disappear over time. But for now some customers aren't satisfied with their vendors. Finally, as the outsourcing firms try to push into new services, they are doing training on the job. While that's not inherently bad, once again it does lower satisfaction because it means projects have more problems and they take longer to complete.”

Not a silver bullet

Meanwhile, the problems afflicting the sector don’t exist solely offshore. While worries about anti-outsourcing legislation and political pressure have dropped dramatically according to DiamondCluster (from 85 percent to 50 percent), concerns about backlash from employees (88 percent), customers (66 percent) and the public (65 percent) persist. These aren’t the only headaches for firms who have outsourced abroad according to Mark Jennings, Vice President of Synergroup Systems.

"Offshore providers are a popular solution for large corporations that need to cut costs, but overseas vendors are not without issues," he suggests. "Workers in India and other popular offshore countries are difficult to oversee and typically require the creation of a US-based management position, complete with a hefty salary and benefits, to act as a liaison between the offshore workers and the corporation. Companies are faced with language and cultural differences, time zone disconnects and the hidden costs encountered when communication breakdowns cause projects to be compromised."

“India, it has rapidly become apparent, is not a silver bullet,” says Graham Underwood, Operations Director at solution provider GFT. “Intelligent businesses are now looking at an outsourcing strategy which includes some nearshoring to resolve this cost/quality dilemma. This considered approach looks at more than just headline day rates and takes into accounts the needs of the project, skills of the workforce, sector knowledge and quality of output. As a result, we are seeing companies move projects back from India.”

Certainly the evidence suggests that companies are beginning to realize that the cost benefits associated with offshore outsourcing are not always worth the effort when compared to the costs of the equivalent nearshore and onshore outsourcing. “Cost savings alone is not a good reason to do offshore outsourcing, that's for certain,” says Weakland. “The cost differential between a place like India and a place like Halifax in Canada, are such that companies may decide that India is not worth the 12 hour time zone differential, not worth being unable to get on a plane and fly there, and not worth some of the communications difficulties. When they stack up all the factors and look at the trade-offs they decide that the extra 5-12 percent savings they would make in India are not worth it.”

Whilst Brazil and Mexico are expected to emerge as nearshore markets for US firms in the near future, at present it is neighboring Canada that offers the most appeal for those businesses looking to outsource nearer to home. “Because of the way that the US dollar and Canadian dollar currently are, there isn’t a major advantage of going to Canada in terms of dollar value savings, but there is a tremendous amount of comfort very specific to Canada for US companies,” says Pavan Kumar Maddali, Vice President of Knowledge Initiative at Satyam Computer Services. “It is a neighboring country, they know how Canada operates, they know the legal structure of Canada and the general way the IT groups work in terms of copyright protection and IP. So there is comfort.”

With corresponding language, culture and time zones, and impressive skills and resource availability, Canada is a popular nearshoring choice. But with a relatively small labour pool population in what is a sparsely populated country and minor dollar savings compared to offshore, Canada isn’t a satisfactory solution for everyone. Furthermore, with other nearshore locations such as Brazil and Mexico still some years away from maturity, a rising number of US firms are turning their attention back to their own shores.

Pocket-friendly prices

While cost savings at a domestic outsourcing company aren’t comparable to those of India and China, low-cost US-based alternatives are sufficient to attract increasing attention. “If you’re comparing Western companies keeping work local versus sending it to remote low-cost markets like India, Eastern Europe of the Philippines, then local outsourcing will not typically provide as much cost savings,” says Stan Lapeak, Managing Director of insourcing and outsourcing advisory firm EquaTerra’s Research, Training and Education Practice. “There are large variances, however, between costs in different Western countries (e.g. the US versus Canada) or even within Western countries (e.g. New York city versus North Dakota). But certain work is more suited for local outsourcing – for example, that which requires closer collaboration and potential on-site work or would be hurt by language/culture barriers, so sending it further offshore could save more money but could also hurt the quality of the deliverable. In these situations a higher cost provider can remain competitive.”

A new breed of low-cost domestic outsourcing firms are now springing up across America’s heartland, providing a tantalizing alternative to offshoring. Companies such as Rural Sourcing, for instance, an application development provider operating in small towns including Greenville, North Carolina and Jonesboro, Arkansas, charges around $40 an hour for programming work compared to the $80 an hour you would expect to pay in a major city like New York. While still considerably more expensive than the $25 or so an hour you would be billed for a good programmer in a major Indian city, for those concerned about hidden costs or other issues blighting offshoring, it can be money well spent. But that isn’t the only reason that onshoring is attracting growing interest.

“There are pockets in the US where you can provide, for example, effective call center services at pretty reasonable rates that, while not as cheap as those offered in India, provide pocket-friendly prices and services without language worries or similar issues,” says Weakland. “There are also a lot of things that you just shouldn't outsource offshore – your data center operations, for instance, or your infrastructure operations. And then there are also a lot of companies that just don't want to move jobs offshore. They listen to Lou Dobbs [the CNN host who has been on a crusade to protect American jobs] and they want to keep jobs in America. So the outsourcing industry in the US is going to be strong for a long, long time.”

Nevertheless, for all the notable growth in nearshore and onshore, reports of offshoring’s demise are vastly exaggerated. DiamondCluster insists that while growth is at a slightly slower pace than in recent years, it is definitely still continuing. And though overall satisfaction with offshore has gone down, the consultancy is similarly confident that the figures will rebound. Indeed, most remain bullish about the future of the sector. “The growth economics of offshore outsourcing will remain unchanged and are going to remain pretty favourable,” suggests Ben Trowbridge, CEO of global outsourcing and insourcing advisory firm Alsbridge. “Despite reports that claim problems like cost inflation and so on, I don’t think the facts will change – it will maintain and/or accelerate continually the next few years.”

Trowbridge similarly dismisses concerns about quality of service. “When I talk to clients they say that they offshore outsource for the cost and stay for the quality,” he continues. “When someone from the West moves work to India, the natural biases because resulting from big cultural differences means that while there are cost savings they assume that the Indians can’t possibly produce the quality. But they end up staying because of the quality – and become a little more multi-cultural.”

Strategic sourcing

With the increasing popularity of nearshoring and onshoring, however, some firms in the modern market could now be forgiven for being confused about where they should outsource their operations. “Companies should develop a services sourcing strategy before undertaking any outsourcing effort,” stresses Lepeak. “This strategy should address when and what to outsource, who is involved with and has the ultimate decision making authority in a sourcing exercise, and how to identify, assess and engage outsourcing service providers. Part of the development of this strategy and undertaking of the sourcing process should involve assessing current in-house capabilities – developing a baseline and then benchmarking cost and performance levels – and determining how much improvement is needed from both a cost and performance perspective.

“If an organization deems it needs significant process improvement from an outsourcing or internal improvement effort, that will drive a different decision-making process, and hence a different decision on where and from whom to source services – or even whether to outsource at all – than if the ultimate goal is to cut as much cost as possible, which would more likely drive an offshore outsourcing effort. But buyers are getting smarter at recognizing the best service delivery model combines on-site, nearshore and offshore.”

This growing realization is leading to an increasing convergence of outsourcing strategies in the sector, with companies such as Satyam Computer Services, for instance, providing a combination of onshore, nearshore and offshore as part of its RightSourcing initiative. “The spread depends on the service levels, the criticality and the kind of importance that the customer would place on the applications being within their boundaries,” explains Satyam’s Maddali. “When there is a very critical application that needs to be managed, and domain and technology knowledge is well entrenched within the organization, it is always onsite. For applications that are not very critical but may have certain service levels and an interaction pattern within their time zone, they may prefer nearshore. And for everything else they would not mind where the work gets done as long as long as the service levels are met. And every kind of need has a combination of this.”

Ultimately, Weakland foresees this trend for convergence characterizing the outsourcing industry’s evolution in coming years. “Over time we'll stop talking about offshore versus nearshore versus onshore outsourcing because the big players are going to have the capability to provide any of those services,” he concludes. “Those type of firms will be virtually indistinguishable from each other. You'll see companies doing what we call 'strategic sourcing' which means looking at the individual organization's goals and constraints and determining the appropriate mix of all resources to do the right job. These resources will include employees, consultants and a variety of outsourced solutions including onshore, nearshore and offshore – putting the right resources in the right location to do the right job.”